What's your risk appetite?

Jan 24, 2011

In this issue:
» FII ownership in Indian stock reaches a peak
» All eyes on the RBI - 'Will it, won't it' isn't the question anymore
» Where is the crude oil price headed?
» India's gold ETFs shine as buyers rush in
» ...and more!!

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"So what's your risk appetite?"

This is a small question that an investment advisor generally asks his client before advising him on an investment. You must have faced a similar question from your advisor as well. On the face of it, this sounds a very simple question, at least for the advisor. But it leads the investor to some confusion and these questions - "What exactly is risk that the advisor is asking about? How do I measure my risk taking ability?"

The irony of this entire discussion is that both the investor and his advisor do not clearly understand what 'risk' actually is. In fact, most investors and advisors don't! But the word sounds fancy, and so it is spoken at will to show the sophistication of the discussion involved.So what does 'risk' really mean?

As per Warren Buffett, the risk of holding any stock (or for that matter, any investment) is only the 'permanent loss of capital'. So 'risk' for you would equate to a total loss of your investment. And your 'risk appetite' would mean your ability to take that total loss.

Of course, as investors, you won't want to buy any investment (like a stock) that can wipe out your money. So it is important to know what you are getting into. Even though some investments won't work out the way you expect, you'll make money over the long haul if you are clearly aware about the risks you are taking.

So, what's your risk appetite? Share with us or post your view on our Facebook page.

 Chart of the day
Today's chart shows the performance of Indian companies on the net profit margin metric. As seen, after dipping in the quarter ended December 2008 (remember that was the peak of the global crisis), India Inc's net margins have recovered to the pre-crisis levels. Currently, of the few companies that have announced their December 2010 quarter results, the net margin stands at around 13.4%, almost same at the levels seen in the previous quarter (ended September 2010). We see these margins coming under some kind of pressure going forward. Our core reason for this belief is the rising cost of money and materials for Indian companies. While commodity prices are already on a tear, interest rates are looking set to rise further as well.

Data Source: CMIE Prowess;
Note: Data is representative of BSE-200 companies

Foreign ownership in listed Indian companies has reached a peak. FIIs raised stakes in a majority of companies. Their aggregate shareholding in the Nifty-50 firms rose to 17.88% in the quarter ended December 2010. Foreign investors invested a record US$ 28 bn (Rs 1.28 trillion) net of sales in 2010. This is expected to rise further as corporate profitability grows. The flow of foreign funds to Indian equities has been quite broad-based, with FII shareholding rising in companies of all sizes and across most sectors.

The growth potential of India remains quite intact. But factors such as high inflation, fiscal and current account deficits, and corruption may act as a wet blanket. And these concerns are weighing on the markets as of now. For the first time since May, FIIs turned net sellers of Indian equities. They sold off US$ 900 m worth of shares in the first fortnight of January. The trend in FII inflows in the months to come will depend on whether concerns such as inflation subside. Many investors will be waiting for the budget next month. The policy cues will be a major trigger for the further course of action.

Crude oil continues to flirt with US$ 100 per barrel mark. Quite understandably then, it is one of the most discussed commodities in the mainstream media. The Financial Times, for example, has written about how the price outlook is covered by global economic fog. The write up makes an attempt to outline three possible scenarios for oil prices going forward.

Scenario one is too sweet to be believed. It predicts strong economic growth for the emerging nations and a sort of 'meandering along' growth for the developed economies. It also points out to reduced tensions between the US and China and stable social and political climate in North Africa and Middle East. The end result? Oil prices remain strong and stabilise around US$ 100 a barrel.

The second scenario presented is that of a supply shock in the form of a terrorist attack with the same sending oil prices soaring to US$ 150 per barrel. The high oil prices push most developed economies back into recession. And the global demand for oil is seen crashing on account of a downward economic spiral.

The third and the final scenario is the likeliest we believe. It talks about how the bluff of a false economic growth is called by persistently high crude oil prices in the region of US$ 100 per barrel. As a consequence, economic growth collapses across the globe, more notably in the developed regions, driving oil prices to very low levels. Later on, prices are driven to such low levels that they allow economies to resume growth. OPEC, standing witness to all these events finally has the good sense to recognise that oil prices much greater than US$ 50 is not in its own long term interest and sanity is restored in oil prices for many more years to come.

Taking into consideration these scenarios, it will indeed take a brave soul to wager too much on which way the oil prices will move next.

Indian markets have started this week on a good note. The BSE-Sensex was trading with gains of around 160 points (0.9%) at the time of writing this. Today's gains were led by stocks from the banking and metals sectors. Other key Asian markets closed mixed. While China and Hong Kong were down 0.3% each, Japan was up 0.6%.

All eyes are set on the RBI as Asia's most conservative central bank is set to take a call on interest rates tomorrow. While the certainty of an interest rate hike is well accepted, the quantum of hike is what is being speculated. For the past few months inflation has brought in difficult times for companies and individuals alike. A steep rise in interest rates may arrest price rises in the medium term. But in the meanwhile consumption and investment both may get affected.

There is no denying the fact that the RBI needs to do what is a must for the long term interests of the economy. But Indian policy makers have of late become very quarterly GDP growth obsessed. Hence for the RBI to walk the fine line in terms of balancing growth and inflation will be a tough task. Especially without sufficient cooperation from the government. We only hope that this time around the rate hikes yield some tangible results on the inflation control front.

Gold ETFs (exchange traded funds) are enjoying the spot of good run they have had since the final months of last year. For the beginning of 2011 looks good as well as religious festivals and the marriage season keep the demand for the precious metal alive. As per the World Gold Council, the total assets under management of all listed gold ETFs in India have grown to about 15 tonne. This is from just 8-9 tonne four months ago. Interestingly, Indians so far have always preferred to buy gold in physical quantities across years. That too most of it as jewellery. Thus, an increased preference towards gold ETFs would mean that the sophistication of Indian consumers is rising.

 Today's investing mantra
"The investor of today does not profit from yesterday's growth." - Warren Buffett

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11 Responses to "What's your risk appetite?"


Jan 24, 2011

For once, I do not agree with Mr. Buffet's view on risk.
Complete loss of money or default risk, although is a major part, but still it is just one amongst the other risks involved in the total risk. The other risks e.g. Inflation, Time, Cash flow etc. are also to be taken into consideration while calculating the overall risk. Mr. Warren Buffet evaluates all his investments by taking risk free rate as his cost of capital as he is sure that a thorough understanding and research of a business is more than enough to invest in the business. However as per me, some of the risk such as event, inflation, interest may not be in the the companies hand in which one is investing. Hence, I believe a thorough evaluation of all the risks is necessary before one goes ahead with investing in the company.

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